What is a Performance Condition?

A performance condition is any situation that can alter the exercisability or vesting of an equity-based award, or other factors that impact the award's fair value. A performance condition relates to either the time period over which an employee provides services, or the completion of a targeted performance goal.

Characteristics of a Performance Condition

The key characteristics of a performance condition are as follows:

Tied to business performance metrics. A performance condition is based on metrics that reflect the operational or financial performance of the company, business unit, or individual, such as earnings per share, revenue growth, or net income.
Defined measurement period. A performance condition applies over a defined period, such as one year, three years, or a custom timeframe. The award is typically evaluated at the end of this period to determine whether the performance targets have been met.
Objective and measurable criteria. The performance criteria should be clear, quantifiable, and objective. For instance, “achieving a 10% revenue increase by the end of the fiscal year” is a well-defined and measurable target.
Vesting or forfeiture based on outcome. If the performance target is achieved, the award vests fully or partially. If the target is not met, some or all of the award may be forfeited or canceled.
Aligned with organizational goals. The performance condition is designed to align employee incentives with company objectives, ensuring that the recipient's efforts contribute to broader business success.
Potential for partial achievement. Some performance conditions include thresholds for partial vesting, such as 50% of the award vests for achieving 80% of the target.
Requires approval. Performance conditions and outcomes are usually subject to approval and certification by the company’s board of directors or compensation committee to ensure fairness and accuracy.

In summary, a performance condition in an equity award serves as a motivating mechanism for employees, aligning their goals with the company’s success and requiring them to meet specific, measurable objectives to earn the award.

Examples of Performance Conditions

Examples of performance conditions are working for an employer for a period of five years, or increasing the profitability of the employer by 20%, or increasing the sales in a new sales region by 50%. Another possible performance condition would be completing two successful patent applications within three years, as would obtaining $1 million of grant funding within two years.